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Understanding the Kiddie Tax Rules

April 24, 2023

Learn more about your tax obligations if you make a financial gift to your children.

Attention parents…thinking of making a financial gift to your children? You might have heard that the so-called “kiddie tax” rules became more burdensome under the Tax Cuts and Jobs Act (TCJA). But that change was only reversed several years ago. The SECURE Act of 2019 retroactively reinstated the old kiddie tax rules. The back-and-forth has confused some taxpayers. Here’s what you should know.

What Is the Kiddie Tax?

The kiddie tax was designed to prevent parents from lowering the family’s tax bill by transferring income-producing assets to children in lower tax brackets. Under IRS rules, for 2023, the first $1,250 of a child’s unearned income (dividends, interest and capital gains) is earned tax-free, and the next $1,250 is taxed at the child’s rate. Anything over $2,500 for 2023 (up from $2,300 for 2022) is taxed at the parents’ tax rate instead of the child’s generally lower rate.

Generally, the kiddie tax applies to all children age 18 or younger, as well as to full-time students who are between 19 to 23 years old and whose earned income is ≤ 50% of his/her support.

Note: You may be able to avoid the kiddie tax if your child has a Roth IRA, or if you save for college in a Section 529 investment account.

What Did the TCJA Change?

The TCJA retained the general idea of the kiddie tax but, instead of being taxed at the parent’s marginal tax rate, the child’s unearned income would be taxed at the federal income tax rates applicable to trusts and estates. The rule was put in place to deter parents from pushing certain types of income into their children’s lower tax rates. The trust and estate income tax rates rise very quickly and reached the top rate (37%) at just $12,950 of taxable income for 2020.

However, the TCJA change created some unintended and negative consequences.

This includes:

  • Each dollar amount of the income bracket for estates and trusts is much smaller, and the maximum tax rate is reached at a lower income level (when compared to the brackets and tax rates for individuals).
  • Governmental payments received by children of deceased military personnel, first responders and emergency medical doctors are considered unearned income and subject to the kiddie tax, a change Congress felt was unfair.

In response, Congress decided to go back to the old rules.

2020 Update

In December 2019, the old kiddie tax rules were reinstated. That means that any income subject to the kiddie tax (investment or unearned income) is (again) taxable at the parents’ marginal tax rate.

The reinstated rules went into effect for tax years beginning in 2020 and beyond. However, taxpayers had the option to apply the pre-TCJA kiddie tax rules to returns filed for the 2019 tax year and amend 2018 if warranted.

Questions on the impact of the kiddie tax on your personal situation? Contact us.

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